Before the Pension Protection Act of 2006, P.L.109-280
(PPA ’06), it was generally understood that an S
corporation’s charitable contribution of appreciated
property reduced each shareholder’s adjusted basis in stock
by the shareholder’s pro-rata share of the charitable
deduction, which often was a portion of the contributed
property’s fair market value (FMV).This potentially could
result in a shareholder’s recognizing gain on the sale of S
stock (due to lower basis) related to the S corporation’s
charitable contributions. If the shareholder had directly
owned and contributed the appreciated property, no indirect
gain to the shareholder would have been recognized. Also,
the use of FMV was inconsistent with the partnership-partner
treatment governed by Rev. Rul. 96-11, which requires that
the basis of a partner’s partnership interest be reduced by
the partner’s share of the contributed property’s basis.

The PPA ’06 corrected this problem for tax years
beginning in 2006 and 2007. (It is hoped that an extension
of this treatment will be enacted in 2008 as part of an
extenders bill.) PPA ’06 Section 1203(a) amended Sec.
1367(a)(2) to limit the reduction in a shareholder’s basis
to the shareholder’s pro-rata share of the S corporation’s
adjusted basis of the contributed property, not the FMV. In
addition, under Section 3(b) of the Tax Technical
Corrections Act of 2007, P.L.110-172, the Sec. 1366(d) basis
limitation does not apply to the amount of appreciation in
property an S corporation contributes to charity.

Importantly, the PPA ’06 does not change the general
shareholder deductibility rule that the deduction is subject
to the Sec. 170 contribution limit and, to the extent of the
property’s basis, does not change the general shareholder
deductibility rule that the deduction is subject to the Sec.
1366(d)(1) basis limitation.

Preparer Actions

S corporations that made charitable gifts of appreciated
property in tax years beginning in 2006 or 2007 should
supply relevant information to shareholders on Schedules
K-1.

Example 1: An S corporation is
owned by one shareholder, A, who has an adjusted
basis of $1,000 in his S stock. In 2007, the S corporation
contributes appreciated property with a basis of $200, an
FMV of $500, and a long-term holding period to a Sec.
501(c)(3) charitable organization. The S corporation will
reflect on Form 1120S, Schedule K, Shareholders’ Pro Rata
Share Items, and A’s Schedule K-1 a separately
reported $500 charitable contribution item.This will be
deductible on A’s Form 1040, Schedule A, Itemized
Deductions, and his adjusted basis in the S stock will be
reduced by $200 (the adjusted basis of the gifted
property) to $800 ($1,000 – $200).

Example 2: Assume the same facts
as in Example 1, except A has a basis in his S
corporation stock (after income items and distributions
are properly reflected) of $150. The adjustment to his
stock basis for the charitable contribution would be $150,
so his basis in stock would be $0. A charitable
contribution deduction of $500 flows through to
A, but because of the Sec. 1366(d) basis
limitation, only $450 is currently deductible—the
aforementioned $150, plus the $300 of appreciation ($500 –
$200). The remaining $50 ($200 – $150) is suspended under
Sec. 1366(d)(2).

Example 3: Assume the same facts
as in Example 1, except A has a basis in his S
corporation stockof $305. A’s basis in his stock
is reduced by $200 to $105 and his charitable contribution
deduction is $500.

Example 4: Assume the same facts
as in Example 1, except A has a basis in his S
corporation stock of $0. A currently deducts $300
as a charitable contribution. His basis in the stock
remains at $0 and he has a $200 suspended charitable
contribution deduction under Sec. 1366(d)(2).

Example 5: Assume the same facts
as in Example 1, except the S corporation sells the
property valued at $500 to the charity on a bargain sale
basis for $400, resulting in a charitable contribution of
$100. The bargain sale rules under Sec. 1011(b) require
that the adjusted basis of the property be allocated
between the sale and the gift by their relative FMVs. The
basis of $200 is therefore allocated $40 to gift basis
($100 ÷ $500 × $200) and $160 to the sale ($400
÷ $500 × $200). Therefore, the charitable
contribution deduction would be $100, and the gain on the
sale would be $240 ($400 – $160). The adjusted basis of
A’s stock would be reduced under Sec. 1366 by $40
and increased by $160 for the gain on sale.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.